In the previous lesson we learned the concepts of statistics and the application of statistical methods to summarize return distributions by the use of measures of central tendency. Measures of central tendency are mean, median and mode. We also discussed the measures of dispersion or risk such as variance and standard deviation and also learned about some advanced concepts like kurtosis and skewness of distributions. Some of these concepts will be required to go through these readings. Though we will try to explain the concepts again if required, it is expected that you have gone through the complete CFA Level 1 Reading 7 provided by CFA Institute.

This session is on Reading 8 as prescribed by CFA Institute Learning Outcome Statement or LOS. We learned about LOS in the first session. Please go through the learning outcome statement for detailed list of Learning Outcomes. After this lesson the candidate should be able to understand the basic probability concepts related to the calculation of the expected return and risk of the portfolio.

Let us now look at the agenda of this lesson.

AGENDA

The agenda of this session is to cover Reading 8 as prescribed by the CFA Level 1 Curriculum. You can go through this reading from Volume 1 of the CFA Level 1 Curriculum made available to you by CFA Institute.

In this lesson we will start by understanding the concept of probability and explain to you some properties of probability. Then we will learn about different ways probability can be estimated. After that we will cover the most important concept of this lesson, which is conditional and unconditional probability. This concept is important because every real life calculation of return and risk is dependent on certain conditions. While explaining these concepts we will study some important rules of probability. Every concept will have rule attached to it. The rule will be discussed with the concept to understand the importance of the rule, its application and significance. After learning conditionality of probability, we will cover types of events (i.e. independent and dependent events). Next we will learn how to calculate the expected value and dispersion or variance of the possible outcomes from the expected value. Calculation of dispersion is important because it is a measure of risk. After learning all of the concepts we will move on to the calculation of expected return and risk of the portfolio. Here we will learn the concept of covariance and correlation. Lastly we will learn about the Bayes’ formula, its significance and principles of counting.